Doing well while doing good: Socially responsible investing

Investing in companies that do something good for humanity and have the potential to generate better risk-adjusted returns seems like a no-brainer. Increasingly, investors seem to agree.

Over the last decade, there has been significant growth in sustainable, responsible and impact investing—or SRI, which can also stand for socially responsible investing—a strategy in which companies that fail to meet certain socially responsible standards are avoided and those making progress in environmental friendliness, social responsibility and corporate governance (ESG) are sought out.

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"The growth [in SRI] has been pretty remarkable," said Mark Peters, principal and member of the investment of Federal Street Advisors, a firm with a substantial focus on SRI and mission-related investing. According to the Forum for Sustainable and Responsible Investment, SRI investing grew 929 percent—a 13.1 percent compounded annual growth rate—between 1995 and 2014.

"More recently, you've had very sharp uptick," Peters said. From the beginning of 2012 to 2014, SRI assets in the U.S. grew 76 percent, to $6.57 trillion, up from $3.74 trillion. The number of stock and bond mutual funds that apply socially responsible mandates has also risen. In the U.S., there are now more than 100 sustainable mutual funds.

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Globally, interest in SRI is even more impressive. Between 2012 and 2014, global assets rose to $21.4 trillion, from $13.3 trillion—an increase of 61 percent, which outpaced the growth in total professionally managed assets, according to the 2014 Global Sustainable Investment Review.

Peters said much of the recent interest has to do with how the category has evolved. In the early days, it was more geared toward religious organizations that wanted to avoid one or two segments, such as companies involved with tobacco or alcohol. Over the last several years, however, the strategy has become more holistic, with a focus on identifying companies that are making positive social or environmental strides.

Among the topics clients are particularly interested in are climate change and other environmental issues.

"We have a lot of clients that want companies with reduced carbon footprints," Peters said. "We help them determine what the exposures are in their portfolios to higher-emitting companies, and we reduce that exposure in a way that makes sense from an investing perspective over the long term."

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Poverty, sustainable agriculture and obesity are also popular topics among SRI investors, Peters said, adding that clients often get access to these areas through community investing, which offers a way to provide funding and resources to low-income or other communities in need.

SRI has also benefited from broader adoption by investment firms that are using more comprehensive SRI data to identify risks within a company. The thinking is that a company focused on using less energy and emitting less waste can operate more efficiently and pay less to get rid of waste. Positive SRI scores could also translate into other positives, such as fewer lawsuits, less regulatory scrutiny and higher employee satisfaction.

Jury's still out

Opinions are mixed about the impact of SRI strategies on performance. However, David Kathman, a mutual fund analyst with Morningstar, said that based on numerous academic studies, the general consensus is that "there will be good times when a social screening will hurt you and times when it will help you, but over time it doesn't make a difference."

"It's neutral," he said. "Basically, a free good."

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One report conducted by Deutsche Bank Climate Change Advisors that was based on more than 100 academic studies (click here to download the report) found SRI strategies to be correlated with superior risk-adjusted returns at a securities level. It also found that companies with high ratings for corporate social responsibility (CSR) and ESG have a lower cost of capital in terms of equity and that companies with high ratings for ESG factors tended to exhibit market-based and accounting-based outperformance.

While it is clear investors are increasingly using their moral compass when it comes to managing their money, Kathman said, "it is possible to overstate the growth if you have the broadest definition [of SRI] possible."

"Basically, anyone who does anything—even just looking at environmental factors—can count," he said. "Even if they're not using the full ESG criteria or SRI process like the core members of the group."

Firms with dedicated SRI practices use comprehensive positive and negative company screens and also engage in community investing and shareholder resolutions in order to provoke companies to make positive changes.

Interest in SRI investing appears to depend largely on factors such as wealth and age.

According to a study by The Spectrem Group, only 20 percent of ultrahigh-net-worth investors said social responsibility of investments was a factor in their investment selections, compared with 36 percent of "mass affluent" investors.

Meanwhile, when rating their level of interest about the social responsibility of investing from 0 to 100, the average score for ultrahigh-net-worth investors under 49 years old was 46.6, compared with an average score of 30.7 for those over 64 years old.

Millennials, in particular, seem to have an acute interest in social responsibility, as evidenced by various studies.

According to The Spectrem Group's 2013 High Net Worth Millennials study, 45 percent of high-net-worth millennials are interested in using their wealth to help others and consider social responsibility a factor when investing their money. This compares with just over 3 in 10 of Gen X investors, baby boomers and seniors.

Although millennials may only account for a small percentage of investing assets currently, as they age and come into more money, they are likely to be a significant driver of future SRI growth.

—By Jennifer Woods, special to CNBC.com